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Will a Pension Support You
September 7th, 2010 | Articles

Can you depend on your pension for lifetime support?

As the average life expectancy of a 65 year old is now 85 for women and 82.4 for men and on the increase, those pondering the purchase of an annuity in this day and age have some hard questions to ask themselves. This annuity represents a large slice of the income they will be living on after they retire. If this occurs at 65, men have an average of 17.4 years and women 20 years to consider with the possibility of this being even longer.

You can choose to buy an annuity which pays you an identical amount each year but this will not save you from inflation, or do you decide to link your annuity to inflation which is extremely costly? Inflation is something that can never be predicted over a long period of time as rates of 25% in 1975 and 10.9% in 1990 testify. Along with the great unknown that is inflation, you also have to factor in potential care costs when you get older.

Even inflation levels which are considered modest can hurt you financially. At a rate of 4%, an annuity worth £1,000 will lose £40 a year in value and within 20 years your £1,000 annuity will only buy you £442 worth of goods and services. Considering that Retail Price Inflation (RPI) is at 5%, this is a serious decision to ponder.

While an annuity linked to inflation may seem like the answer, it could give you 50% less income than what you would receive from its level paying counterpart. If you purchased a £10,000 annuity at the age of 65 with 5% inflation, you would get £573 but only £292 according to Moneyfacts. This initial income loss is huge as it would take 16 years to fully recoup it. This explains why most people who purchase annuities will decide to go for the level paying option.

Solutions to this delicate problem include buying a mixture of the two, maybe purchase 75% of what you want in a level paying annuity and 25% in an annuity that is linked to investment. If your stocks and shares rise in value, this would cover any shortfall from buying a level priced annuity if inflation rates are high. There is also the option of a with profit annuity which sees you invest your pension into a with profit fund. This should rise over time but is not guaranteed while your annuity could fluctuate in value and perhaps even fall.

Billy Burrows, member of annuity firm Burrows & Cummins, believes that although annuities linked to investment are a risk, there is hope that the shares will rise high enough to cancel out any loss due to inflation. This effectively means that those buying annuities will have to share the risk with insurers in order to guard themselves against inflation. Once again, another aspect of personal pensions shows how difficult and risky they can be.

Those who have retired recently can testify to the fact that equities are seldom at their peak when you need them to be and the majority of people’s pension fund will not be big enough to achieve more flexible options. The average price for annuity purchase for an average pension fund is approximately £24,000.

If the government will not provide some safeguards against inflation for pension funds then saving for your pension will always be an unnecessary gamble.

If you haven't found all the answers that you are looking for you can find similar content in the Articles sections, contact an adviser at the top of the page, or you could try these related posts:

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